What is a preference payment when a company is insolvent?

When a company becomes insolvent, the directors are legally obliged to act in the best interests of their creditors as a whole. By making a preference payment, you put a specific creditor in a better position than the other creditors within the same class. That is a breach of your duties as a company director that could have serious consequences if the business subsequently enters a formal insolvency procedure such as Administration or Liquidation. 

What is a preference payment?

A preference payment is a transaction an insolvent company performs that puts a particular creditor or group of creditors in a more favourable financial position than the others. A preference payment does not always have to be a payment. For example, you could grant a connected creditor a charge over an asset while ignoring the others.    

In practice, if you cannot afford to satisfy all your company’s creditors in full, you cannot pick and choose who you repay. If you do, the transaction will be challenged when the company enters Liquidation and you could be held personally liable for the amount or be disqualified from acting as a director for up to 15 years. 

What is classed as a preference payment?

A transaction can be classed as a preference payment if:

• you make it when the company cannot pay all its outstanding debts i.e. it’s insolvent; or
• the company becomes insolvent as a result of the transaction.

Any payments you make to connected creditors (family members, friends, etc.) up to two years before the onset of insolvency can be challenged as preference payments. In the case of unconnected creditors, it’s transactions that occur in the six months before insolvency. 

For a transaction to be classed as a preference payment, you must also have the desire to put the creditor in a better position than its other creditors. That desire is assumed when the payment is made to a connected party.

Here are some examples of transactions that show a preference:

• Repaying a loan that you’ve personally guaranteed as a company director
• Repaying a friend or relative who lent the company money 
• Paying a supplier in the hope that they’ll work with you on a new business venture after your existing company has been liquidated
• Granting a creditor a charge over assets that puts them in a better position 

What happens if you make a preference payment to a creditor?

If the company is insolvent and subsequently enters Administration or Liquidation, an Insolvency Practitioner will be appointed to manage the procedure. As part of their role, they are legally obliged to investigate the conduct of the directors to find out if they’ve acted wrongly in the period during or leading up to the insolvency. 

The Insolvency Practitioner will look closely at all the transactions going into and out of the company. If they find a transaction that shows an unfair preference, they can challenge it and try to recover the funds from the recipient. If the Insolvency Practitioner cannot recover the money from the recipient, they can request that the director pays an amount to the company for the benefit of its creditors. 

As well as financial repercussions, the Insolvency Practitioner must also submit a report of their findings to the Insolvency Service. The Insolvency Service will then decide whether to launch an investigation that could lead to you being disqualified as a director for up to 15 years.

How can I avoid making a preference payment in insolvency?

Given the severity of the consequences, you must be aware of and adhere to your legal duties as a company director. If you believe your company is approaching insolvency or is already insolvent, you should cease trading and seek the advice of an Insolvency Practitioner. They will help you treat all your creditors equally and explore the recovery or closure options available to your business. 

There are some occasions when, as an insolvent company, you could be permitted to pay one creditor over another. For example, you might have to pay rent owed to a commercial landlord for a warehouse so you can fulfil orders that raise additional income for the company and its creditors. However, this is a complex area and one you should only navigate with the advice of an Insolvency Practitioner. If you make this type of payment, you must record your reasons for doing so in the company records.  

Need advice?

At UK Liquidators, our team of licensed Insolvency Practitioners can determine whether your business is insolvent and help you act according to your duties as a company director. Contact us today for a free, same-day consultation or arrange a no-obligation meeting at one of our offices throughout the country.